Assume the current spot rate between the UK and the U.S.is £.6402 per $1.The expected inflation rate in the U.S.is 1.9 percent.The expected inflation rate in the UK is 2.1 percent.If relative purchasing power parity exists, what will the exchange rate be two years from now?

Question

Quizplus · Accepted Answer

According to relative purchasing power parity, the exchange rate will adjust to reflect the difference in expected inflation rates between the two countries. Therefore, the expected change in the exchange rate is equal to the difference in expected inflation rates. In this case, the expected inflation rate in the UK is 2.1% and the expected inflation rate in the US is 1.9%. The difference is 0.2%. Therefore, the expected change in the exchange rate is 0.2%. 
Using the formula: Exchange rate in 2 years = Current exchange rate × (1 + expected inflation rate in the UK) / (1 + expected inflation rate in the US), we can calculate the future exchange rate as follows:
Exchange rate in 2 years = £.6402 × (1 + 0.021) / (1 + 0.019) = £.6417/$1. 
Therefore, the correct answer is C.

Assume the Current Spot Rate Between the UK and the U.S.is